In 1995 the United States Government adopted a National Homeownership Strategy (the “Strategy”) with a primary goal to propel the rate of homeownership to an all-time high by the end of the year 2000. The Strategy is described as “a call to action, not an academic exercise.” In the following quotation, the Strategy cited a major barrier that would have to be overcome to realize this goal: “For many potential homebuyers the lack of cash available to accumulate the required down payment and closing costs is the major impediment to purchasing a home.” The Strategy further suggested that the real estate and lending industries needed to focus on three issues to overcome this barrier: 1) cut transaction costs; 2) reduce down payment and mortgage costs; and 3) increase availability of financing. In addition, a key element of the financing strategy was to pass on savings to consumers created through reengineering both the mortgage and real estate sales process.
The traditional path to homeownership requires the buyer to provide a down payment of approximately four to five times their normal monthly housing cost as a test of their homeownership commitment. This requirement can be difficult to meet for many homebuyers. Saving five or six thousand dollars often requires people to take on a part time job for as long as a year or more, especially when taxes, child care and transportation costs are considered. This means a potential homebuyer may need to spend an additional 400 to 700 hours away from their families while working to accumulate the necessary funds for a downpayment. This time commitment can be very disruptive to normal family life. Testing the buyer's resolve to achieve homeownership in a manner that alienates them from their families is not in the interests of government or the consumer. Also, this process can be especially burdensome for single parent households.
The government has responded to this need with limited down payment assistance programs for first-time and low-income homebuyers. These programs have allowed many to attain homeownership, but it has brought frustration to even more people due to the limited funding availability. Stringent qualifications restrict disbursing funds to only the most needy of applicants. As budget cutbacks are threatened, the prospect of government subsidized programs as a consistent source of down payment assistance looks bleak. While the simplest solution may be to remove the down payment requirement altogether, this would require an act of Congress. The National Housing Act mandates a three percent cash investment from homebuyers using the FHA loan program offered through HUD, the Department of Housing and Urban Development.
Currently, other methods of measuring the buyer's cash contribution into the transaction have been allowed by HUD. One well-known program, Habitat for Humanity, promoted by former President Jimmy Carter, allows lower-income homebuyers to contribute construction labor in what can be described as an old style “barn-raising” cooperative. This type of cash investment, known as “sweat equity”, entered the FHA loan underwriting handbook in December of 1988.
While the Habitat for Humanity program has literally put thousands of people in their own homes across the country, it falls short of being considered a major solution. Because buyers are required to perform labor on the basic structural components of the home, such as framing, roofing, electrical, plumbing, etc., the program requires professional construction supervision to ensure that the participant's efforts meet industry standards. In addition, in the resale market where over 80 percent of the transactions take place, the opportunity for the buyer to provide construction labor as the cash investment does not exist. Also, a physically impaired homebuyer would have difficulty participating. This encourages regulators to seek out a program design that reflects better compliance with the Americans with Disabilities Act, as well as one that is available on more homes to provide better selection.
Chapter 7 of The National Homeownership Strategy introduced homebuyer counseling as a new concept into the discussion of mortgage default prevention. Homebuyer counseling was cited as a practice that effectively reduces the risk of mortgage default. In order to promote its use, the Strategy recommended that pre-purchase counseling become an integral part of the homebuying process, that a predictable stream of funding sources be created for counseling, and that brokers, lenders and counseling providers pool their resources to expand homebuyer education.
Thus, HUD announced an initiative offering to reduce the charge it makes for FHA mortgage insurance by a quarter percent for buyers who participate in a HUD sponsored housing counseling program. The incentive was doubled one year later through Mortgagee Letter 97-37. HUD stated that it believed education made first-time homebuyers better homeowners and borrowers, and that such homebuyers represented a lower risk to the insurance fund. Therefore, the reduction in the amount of the up-front premium collected from these homebuyers was justifiable.
HUD also called upon the real estate and lending industries to market the initiative and even developed a special homebuyer training course called the Homebuyer Education and Learning Program (HELP). In order to promote its use, HUD allows homebuyers to obtain training even after they have become committed to a purchase contract. While it may seem that placing someone through homebuyer training after they contract to buy a home is putting the cart before the horse, HUD has little choice in the matter. HUD cannot force their training into the marketplace, but must work in cooperation with the real estate industry. Since the industry is dominated by a sales force that derives its income from commissions, it may be unrealistic to expect them to turn over control of their client to a government sponsored instructor.
Thus, use of true pre-purchase counseling is all but non-existent in the marketplace. What is actually being performed in order to obtain the FHA mortgage insurance premium discounts is pre-closing counseling. The difference is simple, yet important. Homebuyers are currently being sent to an abbreviated class after they have been obligated in a purchase contract and rarely before. This is in spite of the fact that true pre-purchase counseling was originally declared by HUD as being the preferred format. Mortgagee Letter 98-01 released in January of 1998 reprimanded the industry for allowing grossly inadequate homebuyer counseling in exchange for the mortgage insurance reduction. HUD warned that training must be provided in a classroom, face to face or electronic media format, and involve 15 to 20 hours of instruction to claim the premium discount. It is argued that the industry does not embrace pre-purchase counseling as it tends to undermine their control of the prospective homebuyer. By waiting until the client is obligated in an agreement to purchase a home, real estate agents prevent the possibility of losing a client as a result of information provided to them in homebuyer counseling sessions. Typically, only after purchasing a home is the buyer referred to a counseling program to claim the FHA insurance discount. While this defeats the purpose of educating them, it may well be that pre-closing as opposed to actual pre-purchase counseling is the best voluntary level of compliance HUD can get from the present real estate industry.
HUD's difficulty in enforcing greater compliance with their pre-purchase education al curriculum stems from their policy of financing the mortgage insurance premium. Giving a discount on the up-front mortgage insurance premium does not reduce the buyer's cash investment requirement, it only reduces their monthly payment by approximately $5. The nominal motivation of $5 is not sufficient to compel homebuyers to attend HUD's full 15 hour classroom training. In fact, the incentive is so negligible that acquiring the discount becomes little more than an afterthought. A more compelling reward needs to be offered to entice homebuyers to attend these classes.
One response that resulted from the National Home Ownership Strategy's call to action, was from non-profit organizations that generate down payment assistance through a fee paid by sellers. One such program is known as the Nehemiah Program, operated by Nehemiah 2000 Homeownership Inc. (Nehemiah). Nehemiah imposes a four percent fee on the seller if the seller's buyer is to receive a three percent down payment gift from the program. The trouble with such a design is that transaction costs increase instead of decrease. Buyers are told, that due to the large fee being paid by the seller, it is likely that they will have to pay the seller's full asking price or possibly even more. It is apparent that the non-profit programs are really just providing 100% financing through inflated sales prices, which mitigates the value of such home buying designs. In addition, while such organizations are required to only dispense funds to those that have attended homebuyer counseling, the programs still accept training that occurs after a contract is entered.
Accordingly, public demand exists for a new format in real estate brokerage. Examining the results of the Gallup Poll's annual Honesty and Ethics survey can best prove this. Since entering the poll in 1977, real estate agents have not been able to attain greater than a 17% public confidence rating for possessing high or very high ethics. This compares to the 50%+ratings received by doctors, dentists, engineers and the clergy. By re-engineering the real estate sales process, sufficient funds can be generated to fuel downpayment assistance programs that can entice homebuyers to attend HUD training courses prior to purchasing a home.